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Tailor option agreements to your business and benefit from better productivity and retention. Our experienced team will guide you through the ins and outs, so you can reap the rewards of these agreements.
Option strategies to suit your business goals
Option agreements always seem like a great idea. However, unless you know your way around the legal implications, option strategies can quickly backfire on a business. That’s why it pays to partner with a team that specialise in this area of corporate law.
Optimal Solicitors will help you understand these agreements and deal with the entire process for you – including the decisions related to put and call options, compliance, and any tax implications.
We’ll take care of the paperwork and make sure you avoid common option agreement pitfalls. So you can do a good thing for your people and business, without putting extra pressure on them.
Option agreements explained
What is an option agreement?
Option agreements are commonly put in place with employees, although they can involve other stakeholders depending on the circumstance.
Essentially, they are legally-binding contracts between a company and a third party (the ‘option holder’). When used in the workplace, they explicitly give employees the ‘option’ to purchase shares. If the option holder decides to exercise their right, they can then buy these shares (which are also referred to as ‘option shares’) in the company.
It’s important to note that how they work will depend on whether the agreement involves a call or put option:
This is an option contract where the purchaser is entitled to (though by no means obliged to) buy shares from the seller. This can happen if the conditions in the agreement have been met.
A put option is the opposite, instead working in favour of the seller. The contract forces the option holder to purchase, in accordance with the option detailed in the agreement.
How does an option agreement work?
Option agreements must be extremely clear. Generally, they should include:
- The grant of the call or put option
- The shares in question that are subject to the option
- Details of any payment when the option is exercised
- Information around any conditions which need to be met before the option holder exercises their right
- An exact time period for the option holder to use the option
- Details of the method for exercising the option
- The option price and its calculation details (this could be a fixed price, or a particular formula may be used)
- Information around the circumstances where the option would fall through
- Whether the shareholder will give warranties for the shares
- Any limitations on the shareholder while the option is in use
- If any reorganisation of share capital would impact the option
What is the difference between shares and options?
Shares and options are distinct from each other in four main ways.
Someone who owns shares automatically becomes a shareholder of a company with equity ownership and the associated rights. If they own options, they’re instead entitled to be a shareholder in the future at a pre-agreed price (following the conversion of options into shares).
Options aren’t paid for; instead they are granted or vested. The buyer simply pays the pre-agreed price when they opt to convert options into shares.
Once shares have been issued and allotted, the employee actually owns them. They would then potentially need to pay taxes on dividends, or any capital gains should they choose to sell them.
Vesting and protection
Vesting is where either the shares or options are ‘earned’, and the person owns the whole amount of these following the end of the vesting period. Shares have ‘reverse vesting’ and options have ‘forward vesting’.
With reverse vesting, the shares are given upfront but vesting is reversed: if the employee leaves the company prior to the end of the vesting period, they have to sell the unvested shares to the company. This is generally at no profit. It protects the company from an employee unexpectedly departing and taking a large stake with them.
For forward vesting, the options holder has options incrementally. This protects the business – the options holder is motivated to stay, as the longer they do, the more options they can receive.
Usually, shares trigger an instant tax charge for the employee and employer. This is based on the price paid per share by investors. It’s important to note that, if these shares have no value, there may be no tax implications.
There is initially no tax paid on options. Depending on the individual circumstances (the background and type of share scheme), once the option has been converted there could potentially be Income Tax due as well as NICs. Once the shares are sold, the employee may have to pay CGT.
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Work out your option strategies with Optimal Solicitors
Option agreements can be greatly beneficial. They act as an incentive to motivate employees, and they can be a more tax-efficient way of financially rewarding them.
These types of contracts are incredibly complex, however. From deciding on put and call options, to making sure you correctly follow the rules and processes around option agreements, to knowing the difference between shares and options and the resulting tax implications, there’s a lot to consider.
Therefore, make sure you have every angle covered and that the agreements work in your favour. For this, it’s always sensible to seek legal advice. Optimal Solicitors have a decade of experience in this area. We’ll support you every step of the way, drawing up the necessary paperwork, and making sure that everyone knows their rights and obligations.
What’s more, we make the entire process straightforward – removing the complicated legal jargon, and cutting costs where we can. We even offer other corporate law services and provide an initial consultation.